JPMorgan - Big And Complicated, But Still Undervalued

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 |  About: JPMorgan Chase & Co. (JPM), Includes: BAC, C, USB, WFC
by: Stephen Simpson, CFA

Being the first major bank to report earnings has had its ups and downs for JPMorgan (JPM), and it's pretty clear that the market was not overly fond of this bank's over-complicated first quarter results. All of that said, underlying reported results were pretty solid and the bank remains undervalued on the basis of not especially challenging ROE performance in the coming years.

First Quarter Results - Complicated, But Not Bad

Sifting through all of the charges, gains, and items in a major bank's earnings report is a yeoman's task, and JPMorgan's first quarter was no exception. While the bank's results were pretty good relative to sell-side expectations, they weren't so strong on an absolute basis.

Reported revenue rose 6% on a year-on-year basis, with "adjusted" revenue up about 3% but core revenue down a little less than 2%. Net interest income fell 2% from last year (and 4% sequentially) on a lower (and disappointing) net interest margin of 2.61%. Relative to the likes of Wells Fargo (WFC) and Citigroup (C), JPMorgan definitely underperformed.

Overall fee income was up 13% and largely better than expected, with a big jump in mortgage fees. Like every other bank so far, JPMorgan reported expenses that were once again not only higher than expected, but higher overall. Net-net, core revenue fell about 2%, while expenses were up more than 2%.

Pre-provision net revenue fell about 7% from last year, while credit quality worsened a bit. Provisioning was substantially lower, but the non-performing asset ratio ticked up a bit (like Wells Fargo and Citi) and the loan loss reserve release was offset by a large litigation reserve.

Some Good News

Amidst the unimpressive absolute performance, JPMorgan had some better news. Fixed income trading revenue was down, but other investment banking revenue picked up nicely. Retail revenue was also up strongly and mortgage application volume has rebounded. Card services also did reasonably well.

JPMorgan also ended the quarter with solid progress in its Basel 1 Tier 3 capital - up to about 8.4% against the eventual target of 9.5%.

Plenty Could Go Wrong, But JPMorgan Is Looking To Grow

JPMorgan still has a huge derivatives book and that's going to be a stopping point for some investors. So be it, although the fact that a large percentage of its derivatives are centrally cleared offsets some of the risk, as do offsetting positions.

JPMorgan has talked a lot about ramping up its retail banking operations both in the U.S. and abroad. Relative to the likes of Wells Fargo, there's definite room for improvement when it comes to cross-selling and branch productivity for JPMorgan. That said, competing against banks with a much more focused commitment to retail banking like Wells, U.S. Bancorp (USB), and BB&T (BBT) will not be easy.

The overseas banking opportunity is an interesting one. Bank of America (BAC) has had to backpedal significantly in recent years, and Citigroup has likewise been forced to pull back its operations. With so many traditional large European banks hobbled by their balance sheets and converging international standards reducing the ability of banks to compete with under-capitalized balance sheets, JPMorgan could nevertheless have a strong multi-year growth opportunity ahead of itself.

The Bottom Line

JPMorgan is the largest bank company in the U.S. and one of the largest in the world. While that size gives the bank certain synergies and advantages in its cost of capital, it comes at the cost of nimbleness.

Relative to its current and near-term expected ROE, JPMorgan is notably cheaper than Citi, Bank of America, and PNC (PNC), but more expensive than Wells Fargo and U.S. Bancorp, though not by a large margin. So long as JPMorgan can regain double-digit return on equity, the stock is undervalued today, and if the bank can regain 12% ROE the stock is cheap enough to still be worth considering for purchase today.

Disclosure: I am long BBT, JPM.